Wednesday, 7 November 2007

The Blame Game 2

The finger pointing has started. In a self-serving interview with the BBC, Mervyn King tried to evade responsbility for the Northern Rock crisis. He argued that it was the hapless Chancellor who should carry the can for this fiasco.

Unfortunately for King, facts are stubborn things. It is the Bank of England who is responsible for monetary policy and not the Treasury. Through years of reckless monetary growth, it created the housing bubble. It created the environment for Northern Rock to grow from a modest regional building society into one of the largest housing speculators in history. The FSA also bears some responsibility. It should have voiced concerns about Northern Rock earlier.

Darling, on the other hand, was suddenly confronted with a financial mess, just weeks after taking office. With an eye to protecting tax payers money, he tried to limit the cost of this disaster. In retrospect, it proved impossible once there was a run on the Northern Rock.

King blaming Darling is nothing short of offensive. King should resign now.

The future of Mervyn King, the Governor of the Bank of England, was under threat last night following a public split over the Northern Rock crisis with Alistair Darling, the Chancellor. Mr King used a wide-ranging interview to suggest that the Chancellor could have prevented the run on the bank had he acted on options presented to him in the week leading up to the crisis.

Some say that Mervyn King's position as Bank Governor is now under threat He said offering savers a guarantee that their money was safe had been discussed with the Treasury in the week before the Northern Rock crisis became public.

"There were a range of possibilities [which] were on the table,' he said. "They were all being examined." Mr King also claimed that while giving public assurances on savers' money, Mr Darling actually "didn't know how far he could go in giving a government guarantee".

Mr King used the BBC interview to allege that Mr Darling had effectively blocked a takeover of Northern Rock by another bank. Mr Darling has denied the accusation that he could have done more to avert the crisis.

But critics yesterday claimed the row risked undermining efforts by the Government to handle the effects of the global credit crisis. Tomorrow, the Bank of England will announce whether it will cut interest rates and Mr King may well have the casting vote on the decision.

4 comments:

Anonymous
said...

Sorry, but you are wrong on this one. It is the government/treasury who set the inflation target and who structured the MPC. How can they be expected to control the housing bubble if they are told to target CPI which includes no element of housing! The blame for that lies firmly with the government.

Did you listen to King's interview? He said that he pushed hard for a change to the system for protecting cusomer deposits months before NRK collapsed, while Brown was still chancellor. Brown of course didn't listen.

King is doing his job as he has been told to do, and is doing a damn sight better job than most other central bankers. His comments on moral hazard in the interview were telling.

The credit squeeze was the first trial of the Bank of England’s framework for market oper­ations introduced last year. Unfortunately, the verdict is “guilty”, with the smoking gun found in the Bank’s own “red book”, as the framework is known. This is not because of the Northern Rock collapse – probably un­avoidable – but because the Bank did not meet two red book objectives: to keep short-term money market rates consistent with Bank rate until the next monetary policy committee meeting and to ensure efficient liquidity distribution even in stressed conditions.

Other central banks struggled but the Bank underperformed its peers. Charge number one is tardiness. Money market interest rates rose sharply on August 9. The European Central Bank added emergency short-term funds that day; the Federal Re­serve a day later. The following week, the Fed cut its emergency funding rate to half a point above its policy rate; on August 22 a special ECB operation supplied three-month funds at an au­ction-determined rate. The Bank’s first move came on September 5 when it said it would intervene a week later if conditions remained stressed. The actual supply of funds on September 13 occurred more than a month after the crisis broke.

Charge two concerns the Bank’s insistence on charging a 1 percentage point penalty premium on emergency lending. This condition applied to standard emergency lending and its special supply of three-month money announced on September 19, despite the Fed’s cut to half a point and the ECB’s auction-determined rates, which yielded average rates of 0.52-0.61 percentage points above its policy rate. This contradicts the red book, which says emergency lending rate cuts ­relative to Bank rate can be used to relieve stressed market conditions.

Third, banks’ access to emergency funds was constrained by stricter rules than elsewhere. Normally, the Bank restricts collateral to securities of public sector bodies with credit ratings of Aa3 or higher. UK banks hold few such securities. By contrast, the ECB allows private sector assets to be used, with a lower rating threshold of A. The Fed’s definition is similarly broad but has no specified rating minimum. The Bank loosened requirements for its September 19 operations but the stricter rules are maintained for other operations.

The Bank would say alternative actions could not have worked, given the crisis’s depth. It might also say its inactivity until September reflected the UK system’s distinctive features, in particular banks’ ability to choose target levels for deposits at the Bank once a month, with the Bank then ensuring sufficient funds at a non-penal rate. On this view, it made sense to delay action until a new reserves maintenance period started on September 6.

In reality, illiquidity could not be relieved simply by banks requesting higher reserves targets. Once targets are set, banks must maintain actual re­serves within 1 per cent of the specified amount on average over the maintenance period; deviations incur penalties. Thus, additional reserves supplied on September 6 could not meet banks’ demand for a cushion to meet unforeseen liquidity demands. This was provided only on September 13, when the Bank widened the permitted deviation from reserves targets from 1 per cent to 37.5 per cent. This move could have been made earlier and is mentioned in the red book as another instrument to relieve stressed conditions.

The Bank might say the speedier actions elsewhere had little effect. Yet, while US and eurozone money market rates remained high relative to official rates, the gaps were lower than in the UK over the month to mid-September.

Finally, the Bank could argue that the fall in market rates in recent weeks, including relative to eurozone and US rates, shows it has regained control. Some commentators have even said the banks’ unwillingness to participate in the Bank’s three-month operations justifies earlier inaction.

Such claims neglect the liquidity impact of the Bank’s lending to Northern Rock. This succeeded in breaking the logjam in markets where its operational actions had failed. Market rates began to decline on September 14, the day of the bailout. In effect, Northern Rock’s shareholders paid the penalty rate demanded by the Bank to supply the banking system with liquidity.

The Bank was tardy and failed to follow its framework. Recent events also show the red book needs revising: the Bank should widen its definition of eligible collateral and add three-month money auctions as an instrument for maintaining functioning markets.

The Bank said it would not intervene to bring down LIBOR because it believed that the elevated level of LIBOR was a true reflection of increased risk. Also at the time, LIBOR was an illusion because no banks were actually lending to each other anyway. So intervening to bring it down was a pointless exercise.

When the bank did offer some extra cash at auction, no-one even placed a bid, because they were happily getting the cash from the ECB already, and didn't want the stigma that had fallen on NRK when it borrowed from the Bank.

Mervyn had warned about the risk of these markets becoming illiquid months beforehand and nobody listened to him.

Secondly on widening the eligible collateral - why should the bank take these risks? The Fed has been highly irresponsible in doing so, they are accepting boat loans FFS! How safe are THOSE? Why should all sterling holders suffer from the inflation caused when these assets prove worthless and the liquidity cannot be mopped up? If I was the Bank I would be accepting Gilts and nothing less! No mortgage backed securities! They are as good as junk!!!